EUR 850.00 For Business Accounts Only

Morningstar | Aerospace Flying High in 3Q, While Rockwell Close and Break-up Looms on Horizon for United Tech. See Updated Analyst Note from 23 Oct 2018

United Technologies' third quarter beat consensus, and management raised 2018 guidance for revenue and EPS thanks to performance out of its aerospace businesses. We're looking ahead to a Rockwell deal close, which we incorporate in our base case, within the next six weeks or less and to an announcement regarding a potential break-up following closing. Our discounted cash flow valuation sits at $144 per share up from $140 on higher-than-expected 2018 revenue coupled with the impact from the time value of money. However, lower Otis profits and growth over the next several years partially offset these positive elements. Our sum of parts valuation stands at around $186 based on Pitchbook EV/EBIT multiples for peers.

This quarter featured a 10% jump in sales (8% organic), which was the fastest since 2011. Consolidated GAAP EPS was down 8% versus last year but adjusted EPS rose 12% to $1.93. The aerospace businesses fueled the quarter with Pratt & Whitney, registering 13% organic year-over-year growth due to GTF deliveries (large commercial engine sales up 27%) and UTAS coming in at 9% organic growth. Both businesses suffered margin compression: UTAS operating margins contracted slightly to 15.4% and Pratt & Whitney continues to work through early GTF deliveries and associated costs, turning in meager 2.3% margins. CCS put in a solid quarter of 7% organic growth. Despite being most exposed to tariff headwinds, CCS expanded margins to 17.3% from 16.9% last year thanks to pricing.

However, we're increasingly concerned about Otis. Efficiency gains of around 2% (about $60 million of additional profit) couldn’t offset cost increases, resulting in 230 basis points of margin contraction. While the Chinese and European regions seem to be stabilizing, Otis still faces stiff competition in these markets and Korea appears to be a problem now. Management not only reduced Otis' guidance for 2018 but also backed off its 2020 targets for the business and didn’t provide new bogies.

Rockwell continues to be the pacing item for an announcement around the future operating structure of United Technologies. Management believes that politics aren't impacting Chinese regulatory approval of the deal and maintain that the acquisition should close within the next six weeks or less. We continue to model the Rockwell deal in our base case, but we think this assumes nothing changes in the intervening period between China and the U.S., which isn't a given.

Turning to a potential break-up, as we anticipated it appears United Technologies' aerospace businesses will be separated from CCS and Otis. The only question now in our minds is what this divorce will look like exactly. We believe Pratt & Whitney and UTAS will remain together. The two aerospace units of United Technologies are one of the largest aerospace suppliers globally and can certainly compete on their own. In our sum of parts valuation, we calculate that the aerospace businesses account for 69% of the enterprise value of United Technologies. But how management will deal with CCS and Otis is a bit harder to foresee. Anti-trust concerns might preclude an outright sale of either CCS or Otis to a strategic buyer, which seems to point toward a spin-off or the acquisition of one of these units by a non-strategic/non-traditional buyer.